DeFi Lending

In Defi, providing coins to borrowers is a good way for lenders to earn interest and maintain exposure to the underlying coin. In many cases, coin borrowers intend to either increase their long exposure to, or short-sell a specific coin. Lenders, or the protocols that DeFi lenders enter into loan agreements on, typically set parameters for the loans. LTV’s and other hard-coded rules set boundaries on leverage availability based on the type of coin being posted as collateral.

In traditional finance, centralized institutions (brokers/banks) offer loans (leverage) to their customers to facilitate leverage trading. In Defi, lending platforms like Compound and Aave facilitate coin/token loans. DeFi lenders supply their tokens to a particular lending protocol which send the supplied tokens to a smart contract so they can become available to borrowers of various of those tokens to enable leverage trading activity, or further rehypothecation.

The lenders of the tokens are issued placeholder tokens, such as “aTokens” in Aave and “cTokens” in Compound, which represent the supplied tokens plus interest accrual. The amount that a lender receives for their placeholder token depends on the current exchange rate for a particular market and how long that market has been operating.

These placeholder tokens are usually ERC20 issued tokens and can be sent to any wallet. In order for the lender to receive their ETH plus interest, they must redeem the placeholder ERC20 tokens back to ETH on the platform they issued the loan (i.e. Aave & Compound).

Generally, DeFi lending platform APY’s are dictated by market supply and demand. Stablecoins are generally in demand by many market participants and will often exhibit a very high borrowing cost as a result.

Lending markets create a way for coin holders to “put their coins to work”, while offering leverage trading participants to expose more capital to a particular trading strategy. Given the relative scarcity of any given coin or token, lenders can provide increased temporary liquidity to DeFi traders, in exchange for an interest rate and protocol remuneration through a governance token. 

Borrowing from traditional financial primitives, but expressing them in a DeFi setting has been both challenging and lucrative for new DeFi protocols. While lending rates typically float with supply and demand, there are many DeFi participants working on structuring a yield curve with term-based lending at different durations. Aave is one of the first platforms to offer term lending at a defined fixed rate.